Can you use the same performance measure for both the STI and the LTI?

While Guerdon Associates is a board adviser, we are often asked for our assessment of an executive remuneration structure by institutional investors we have come to know over the years. An institutional investor, in course of revising their policy approach to remuneration, recently asked us a question we get every season.

“Should it be acceptable that an executive is rewarded for achieving outcomes on the same measure for STI and LTI? Isn’t this just doubling up?”

Here’s what we said.

It makes absolute sense to measure the same things over different time

periods because it:

  • rewards sustainability,
  • discourages volatility, and
  • discourages excessive risk taking.

If the performance measure was only for the short term, the longer-term performance might suffer (particularly when you think about the average term of a CEO in Australia is about 5.5 years).

An example of this might be ROCE for the STI award.

A good ROCE can be achieved if management defer maintenance capex for a few years. What follows is a less than satisfactory ROCE in the subsequent years.

Hence, if ROCE was the measure for both the short and long term incentives and was set at a sufficiently challenging level, management are required to consistently pull all the right levers to get a sustainable performance.

Conversely, a focus on the LTI without regard for the short term can result in lumpy annual results, and a riskiness discount.

Another example is the application of EPS growth. For an LTI, an EPS CAGR measure depends on the beginning EPS and the ending EPS, say, 4 years later. So, management only has to arrange things so that the fourth year EPS is maximized to ensure a good growth rate. However, annual STI EPS growth and longer-term LTI EPS growth rewards sustainability, discourages volatility, and so reduces the risk discount on the share price. (Yes, for the purists, we do appreciate we’re ignoring the impact of annual LTI grants, but we’re simply seeking to demonstrate the point).

The same performance measure applied to different performance periods is not measuring the same thing twice.

The same thing is the same performance measure over the same period.

The same performance measure over different periods is not the same thing. This approach, and the rationale, should be encouraged. Investors and investor advisers that do not permit this in their guidelines may need to re-consider their approach.

© Guerdon Associates 2024
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